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3. The Influence of the State on the Monetary System

State activity in the monetary sphere was originally restricted to the manufacture of coins. To supply ingots of the greatest possible degree of similarity in appearance, weight, and fineness, and provide them with a stamp that was not too easy to imitate and that could be recognized by everybody as the sign of the state coinage, was and still is the premier task of state monetary activity. Beginning with this, the influence of the state in the monetary sphere has gradually extended.

Progress in monetary technique has been slow. At first, the impression on a coin was merely a proof of the genuineness of its material, including its degree of fineness, while the weight had to be separately checked at each payment. (In the present state of knowledge this cannot be stated dogmatically; and in any case the development is not likely to have followed the same lines everywhere.) Later, different kinds of coins were distinguished, all the separate coins of any particular kind being regarded as interchangeable. The next step after the innovation of classified money. was the development of the parallel standard. This consisted in the juxtaposition of two monetary systems, one based on gold commodity money, and one on silver. The coins belonging to each separate system constituted a self-contained group. Their weights bore a definite relation to each other, and the state gave them a legal relation also, in the same proportion, by sanctioning the commercial practice which had gradually been established of regarding different coins of the same metal as interchangeable. This stage was reached without further state influence. All that the state had done till then in the monetary sphere was to provide the coins for commercial use. As controller of the mint, it supplied in handy form pieces of metal of specific weight and fineness, stamped in such a way that everybody could recognize without difficulty what their metallic content was and whence they originated. As legislator, the state attributed legal tender to these coins—the significance of this has just been expounded—and as judge it applied this legal provision. But the matter did not end at this stage. For about the last two hundred years the influence of the state on the monetary system has been greater than this. One thing, however, must be made clear; even now the state has not the power of directly making anything into money, that is to say into a common medium of exchange. Even nowadays, it is only the practice of the individuals who take part in business that can make a commodity into a medium of exchange. But the state's influence on commercial usage, both potential and actual, has increased. It has increased, first, because the state's own importance as an economic agent has increased; because it occupies a greater place as buyer and seller as payer of wages and levier of taxes, than in past centuries. In this there is nothing that is remarkable or that needs special emphasis. It is obvious that the influence of an economic agent on the choice of a monetary commodity will be the greater in proportion to its share in the dealings of the market; and there is no reason to suppose that there should be any difference in the case of the one particular economic agent, the state.

But, besides this, the state exercises a special influence on the choice of the monetary commodity, which is due not to its commercial position nor to its authority as legislator and judge, but to its official standing as controller of the mint and to its power to change the character of the money substitutes in circulation.

The influence of the state on the monetary system is usually that ascribed to its legislative and judicial authority. It is assumed that the law, which can authoritatively alter the tenor of existing debt relations and force new contracts of indebtedness in a particular direction, enables the state to exercise a deciding influence in the choice of the commercial medium of exchange.

Nowadays the most extreme form of this argument is to be found in Knapp's State Theory of Money;1 but very few German writers are completely free from it. Helfferich may be mentioned as an example. It is true that this writer declares, with regard to the origin of money, that it is perhaps doubtful whether it was not the function of common medium of exchange alone that sufficed to make a thing money and to make money the standard of deferred payments of every kind. Nevertheless, he constantly regards it as quite beyond any sort of doubt that for our present economic organization certain kinds of money in some countries, and the whole monetary system in other countries, are money, and function as a medium of exchange, only because compulsory payments and obligations contracted in terms of money must or may be fulfilled in terms of these particular objects.2

It would be difficult to agree with views of this nature. They fail to recognize the meaning of state intervention in the monetary sphere. By declaring an object to be fitted in the juristic sense for the liquidation of liabilities expressed in terms of money, the state cannot influence the choice of a medium of exchange, which belongs to those engaged in business. History shows that those states that have wanted their subjects to accept a new monetary system have regularly chosen other means than this of achieving their ends.

The establishment of a legal ratio for the discharge of obligations incurred under the regime of the superseded kind of money constitutes a merely secondary measure which is significant only in connection with the change of standard which is achieved by other means. The provision that taxes are in future to be paid in the new kind of money, and that other liabilities imposed in terms of money will be fulfilled only in the new money, is a consequence of the transition to the new standard. It proves effective only when the new kind of money has become a common medium of exchange in commerce generally. A monetary policy can never be carried out merely by legislative means, by an alteration in the legal definitions of the content of contracts of indebtedness and of the system of public expenditure; it must be based on the executive authority of the state as controller of the mint and as issuer of claims to money, payable on demand, that can take the place of money in commerce. The necessary measures must not merely be passively recorded in the protocols of legislative assemblies and official gazettes, but—often at great financial sacrifice—must be actually put into operation.

A country that wishes to persuade its subjects to go over from one precious-metal standard to another cannot rest content with expressing this aspiration in appropriate provisions of the civil and fiscal law. It must make the new money take the commercial place of the old. Exactly the same is true of the transition from a credit-money or fiat-money standard to commodity money. No statesman faced with the task of such a change has ever had even a momentary doubt about the matter. It is not the enactment of a legal ratio and the order that taxes are to be paid in the new money that are the decisive steps, but the provision of the necessary quantity of the new money and the withdrawal of the old.

This may be confirmed by a few historical examples. First, the impossibility of modifying the monetary system merely by the exercise of authority may be illustrated by the ill success of bimetallistic legislation. This was once thought to offer a simple solution of a big problem. For thousands of years, gold and silver had been employed side by side as commodity money; but the continuance of this practice had constantly grown more burdensome, for the parallel standard, or simultaneous employment as currency of two kinds of commodity, has many disadvantages. Since no spontaneous assistance was to be expected from the individuals engaged in business, the state decided to intervene in the hope of cutting the Gordian knot. Just as it had previously removed certain obvious difficulties by declaring that debts contracted in terms of thalers might be discharged by payment of twice as many half-thalers or four times as many quarter-thalers, so it now proceeded to establish a fixed ratio between the two different precious metals. Debts payable in silver, for instance, could be discharged by payment of 1 : 15½ times the same weight of gold. It was thought that this had solved the problem, while in fact the difficulties that it involved had not even been suspected; as events were to prove. All the results followed that are attributed by Gresham's law to the legislative equating of coins of unequal value. In all debt settlements and similar payments, only that money was used which the law rated more highly than the market. When the law had happened to hit upon the existing market ratio as its par, then this effect was delayed a little until the next movement in the prices of the precious metals. But it was bound to occur as soon as a difference arose between the legislative and the market ratios of the two kinds of money. The parallel standard was thus turned, not into a double standard, as the legislators had intended, but into an alternative standard.

The primary result of this was a decision, for a little while at least, between the two precious metals. Not that this was what the state had intended. On the contrary, the state had no thought whatever of deciding in favor of the use of one or the other metal; it had hoped to secure the circulation of both. But the official regulation, which in declaring the reciprocal substitutability of gold and silver money overestimated the market ratio of the one in terms of the other, merely succeeded in differentiating the utility of the two for monetary purposes. The consequence was the increased employment of one of the metals and the disappearance of the other. The legislative and judicial intervention of the state had completely failed. It had been demonstrated, in striking fashion, that the state alone could not make a commodity into a common medium of exchange, that is, into money, but that this could be done only by the common action of all the individuals engaged in business.

But what the state fails to achieve through legislative means may be to a certain degree within its power as controller of the mint. It was in the latter capacity that the state intervened when the alternative standard was replaced by permanent monometallism. This happened in various ways. The transition was quite simple and easy when the action of the state consisted in preventing a return to the temporarily undervalued metal in one of the alternating monometallic periods by rescinding the fight of free coinage. The matter was even simpler in those countries where one or the other metal had gained the upper hand before the state had reached the stage necessary for the modern type of regulation, so that all that remained for the law to do was to sanction a situation that was already established.

The problem was much more difficult when the state attempted to persuade businessmen to abandon the metal that was being used and adopt the other. In this case, the state had to manufacture the necessary quantity of the new metal, exchange it for the old currency, and either turn the metal thus withdrawn from circulation into token coinage or sell it for nonmonetary use or for recoinage abroad. The reform of the German monetary system after the foundation of the Reich in 1871 may be regarded as a perfect example of the transition from one metallic commodity standard to another. The difficulties that this involved, and that were overcome by the help of the French war indemnity, are well known. They were involved in the performance of two tasks—the provision of the gold and the disposal of the silver. This and nothing else was the essence of the problem that had to be solved when the decision was taken to change the standard. The Reich completed the transition to gold by giving gold and claims to gold in exchange for the silver money and claims to silver money held by its citizens. The corresponding alterations in the law were mere accompaniments of the change.3

The change of standard occurred in just the same way in Austria-Hungary, Russia, and the other countries that reformed their monetary systems in the succeeding years. Here also the problem was merely that of providing the requisite quantities of gold and setting them in circulation among those engaged in business in place of the media previously employed. This process was extraordinarily facilitated and, what was even more to the point, the amount of gold necessary for the changeover was considerably decreased, by the device of permitting the coins constituting the old fiat money or credit money to remain wholly or partly in circulation, while fundamentally changing their economic character by transforming them into claims that were always convertible into the new kind of money. This gave a different outward appearance to the transaction, but it remained in essence the same. It is scarcely open to question that the steps taken by those countries that adopted this kind of monetary policy consisted essentially in the provision of quantities of metal.

The exaggeration of the importance in monetary policy of the power at the disposal of the state in its legislative capacity can only be attributed to superficial observation of the processes involved in the transition from commodity money to credit money. This transition has normally been achieved by means of a state declaration that inconvertible claims to money were as good means of payment as money itself. As a rule, it has not been the object of such a declaration to carry out a change of standard and substitute credit money for commodity money. In the great majority of cases, the state has taken such measures merely with certain fiscal ends in view. It has aimed to increase its own resources by the creation of credit money. In the pursuit of such a plan as this, the diminution of the money's purchasing power could hardly seem desirable. And yet it has always been this depreciation in value which, through the coming into play of Gresham's law, has caused the change of monetary standard. It would be quite out of harmony with the facts to assert that cash payments had ever been stopped; that is, that the permanent convertibility of the notes had been suspended, with the intention of effecting a transition to a credit standard. This result has always come to pass against the will of the state, not in accordance with it.

Business usage alone can transform a commodity into a common medium of exchange. It is not the state, but the common practice of all those who have dealings in the market, that creates money. It follows that state regulation attributing general power of debt liquidation to a commodity is unable of itself to make that commodity into money. If the state creates credit money—and this is naturally true in a still greater degree of fiat money—it can do so only by taking things that are already in circulation as money substitutes (that is, as perfectly secure and immediately convertible claims to money) and isolating them for purposes of valuation by depriving them of their essential characteristic of permanent convertibility. Commerce would always protect itself against any other method of introducing a government credit currency. The attempt to put credit money into circulation has never been successful, except when the coins or notes in question have already been in circulation as money substitutes.4

This is the limit of the constantly overestimated influence of the state on the monetary system. What the state can do in certain circumstances, by means of its position as controller of the mint, by means of its power of altering the character of money substitutes and depriving them of their standing as claims to money that are payable on demand, and above all by means of those financial resources which permit it to bear the cost of a change of currency, is to persuade commerce to abandon one sort of money and adopt another. That is all.